Monday, October 20, 2008

There's been a fair amount of ink spilled on whether Sen. Obama's claim that he would give tax cuts to 95 percent of Americans is legit. The key point is whether a transfer made to an individual who does not currently pay income taxes can be counted as a "tax cut."

The core component of Sen. Obama's tax cut plan is called "Making Work Pay." I've discussed it elsewhere, but the key claim is that it provides a $500 refundable income tax credit for each worker, for a maximum of $1000 per couple. The Tax Policy Center estimates its 10-year cost at $710 billion, so it's obviously a big-ticket item in Obama's tax agenda.

So here's the question: how should we categorize these policies?

The Tax Foundation reports that 33 percent of filers currently pay no net income taxes, which means that 67 percent of filers do. Since 95 percent is larger than 67 percent, it's seemingly hard for Sen. Obama to argue that 95 of Americans will receive a tax cut when only 67 percent are paying taxes in the first place. The Wall Street Journal editorial page relies on this argument in calling Obama's claims an "illusion."

But note that the references above are to the percentage of Americans paying income taxes. Most or all of the tax filers who do not pay income taxes do pay payroll taxes for Social Security and Medicare. Obama's plan is clearly designed to compensate workers for the employee share of the Social Security payroll tax, which is 6.2 percent of all wages under $102,000. Under Obama's plan, workers would receive a refundable tax credit equal to 6.2% of wages up to $8,000, with a maximum credit of $500 per worker and $1,000 per couple. In effect, workers earning $8,000 would receive a full rebate of their Social Security payroll taxes while those earning more would receive a partial rebate. Obama economic advisor Jason Furman says, "Senator Obama believes that the tens of millions of families working hard and paying payroll taxes do not think that tax cuts are a form of 'welfare' or 'redistribution' - they think it is only fair to reward work."

Having laid that out, a few points seem relevant:

In a purely technical sense, Sen. Obama's plan is not giving tax cuts to people who don't pay taxes; it's giving refundable income tax credits to compensate low earners for their Social Security payroll taxes. So score one for Obama, I guess.

However, Obama's proposal ignores what's really going on: cutting Social Security payroll taxes for low earners, who already receive more in benefits than they pay in taxes – that is, their "net taxes" are negative – and filling the gap in Social Security's funding using income tax revenues. That's the clearest explanation of what's going on and would be the simplest way to structure what Obama wants to accomplish. If Obama wants to cut payroll taxes, he should cut payroll taxes – without obscuring the effects of his plan on both Social Security progressivity and solvency.

The only problem is that, viewed transparently, almost no one would agree that it's particularly good policy – certainly not a policy worth $710 billion over 10 years, given everything else on our plate. His plan would make Social Security much more progressive and move it toward a "welfare program." And if we didn't fill the gap with income tax revenues, Social Security's long-term deficit would be increased by almost 60 percent.

Leaving aside the merits, or lack thereof, of Obama's tax plan, the way he is describing it is intellectually dishonest. Furthermore, it is a prime example of the sort of "Washington-speak" that creates huge problems that are difficult to solve. Government says it is doing one thing when it is really doing another.

In my mind I can see Jon Lovitz on SNL, "Refundable tax credits. Yeah, that's the ticket!"

That's in important point: there's a simple way to explain Obama's plan, but very few people would support it. So they use a much more complicated explanation. That doesn't tell me they have much confidence that the public is behind their approach to these things.

>>We think that Sen. Obama should not give tax cut to the upper class because the middle class needs it the most.

This is a specious and vacuous comment. Conceding for the moment that tax policy should be based on "need," who should be the arbiter of said need? It is satisfying to argue that a struggling mother deserves a meal more than a CEO needs another yacht, and on humanistic terms this seems quite true. The more relevant comparison might be contrasting the teacher making $40,000 who through thrift owns a home and has a small nest egg to the recent humanities graduate making $40,000 with maxed out credit cards. Who is more deserving of a tax credit? A refund? Are these people middle class? Lower class? At what point does one decide that yes this salary is definitively upper class and not worthy of any tax relief? Is it fair that certain people pay no taxes at all?

The simple truth is that a tax cut for anyone is good for everyone. An even better notion would be across the board tax cuts with across the board spending cuts, with many government programs (debacles) being completely abandoned.

Class warfare is lovingly cultivated by politicians for their own aggrandizement; buying votes is a long honored tradition among the political subspecies, one effect of which has been to turn many against the very engines of their own prosperity, business itself. It is amazing to me that there remain individuals who cannot comprehend, despite decades of evidence, that more government means less prosperity.

Referencing the 10/21/08 3:04 PM Anonymous entry. No, not every tax cut program is beneficial like for instance the Obama proposed one which diverts Social Security funding but doesn't reduce the payout or benefits of Social Security.

I'm a little curious if the unemployment rate will go up with the higher business taxes.

Obama says his income tax plan will lower taxes for 95% of Americans. There is just one problem with this, 40% of Americans already pay no income tax. Obama's response to this is that these people pay Social Security tax. Well, that's not income tax, but a contribution to their retirement plan. So if he wins and implements his tax plan, for the first time in the history of Social Security, 40% of the people who will get retirement benefits will have paid nothing for them. Social Security will then loose all pretext of being a retirement plan, and will become a national welfare program.

This will cause Social Security to lose public support in a massive way. Leave Social Security contributions out of income tax plans. If you take some peoples income taxes to pay others Social Security taxes, Social Security will be destroyed forever.

About me

I am a Resident Scholar at the American Enterprise Institute in Washington, where my work focuses on Social Security policy. Previously I held several positions within the Social Security Administration, including Deputy Commissioner for Policy and principal Deputy Commissioner. Prior to that I was a Social Security Analyst at the Cato Institute. In 2005 I worked on Social Security reform at the White House National Economic Council, and in 2001 I was on the staff of the President's Commission to Strengthen Social Security. My Bachelor's degree is from the Queen's University of Belfast, Northern Ireland. I have Master's degrees from Cambridge University and the University of London and a Ph.D. from the London School of Economics and Political Science. I can be contacted at andrew.biggs @ aei.org.